Italy maintains a restrictive monetary policy. The removal of the wage and price controls of the Fascist regime and the sheer amount of currency in circulation spark inflation. A law allowing exporters to keep 50 percent of their revenues in foreign currency means most exporters hold on to as many dollars as possible. Combined with inflation, this leads to a series of devaluations of the lira.
Monetary policy loosens as firms invest their profits and borrow less. The rapid expansion in liquidity reduces interest rates. After dropping to 2.7 percent in 1960, inflation picks up again and reaches 7.6 percent in 1963. The Bank of Italy imposes a harsh credit squeeze to tackle inflation just as the economic boom comes to an end. Inflation slows, but so do investment and domestic demand.
The Bank of Italy continues to implement restrictive domestic monetary measures, coupled with a government austerity program to combat inflation. Various experiments with price controls fail. Italy adopts a devaluation strategy which aggravates inflation, raising the price of imports.
The rise in oil prices contributes to inflation. The government believes earlier restrictive policies to be partly responsible for the economic crisis. It initiates an expansionary monetary and fiscal policy, abolishing bank credit ceilings and lowering the discount rate. While inflation begins to drop, these policies bring a decrease in total output and investment.
The lira depreciates sharply in early 1976, and the official exchange market closes for two months. To prevent a deeper fall, the authorities reinitiate tightening measures. The lira strengthens in 1977, and interest rates rise. Companies begin to borrow abroad. A grant of credit from the International Monetary Fund and the EEC improves Italy's balance of payments and the performance of the lira.
In 1979 Italy becomes a founding member of the European Monetary System (EMS), created to stabilize foreign exchange and counter inflation, and adheres to its exchange-rate mechanism (ERM). Inflation, however, surpasses 21 percent in 1980. A major banking scandal forces the liquidation of the Banco Ambrosiano of Milan, the country's largest private bank.
As European integration increases, uneven management of Italy's finances severely weakens Italy's standing in Europe. Prime Minister Craxi succeeds in bringing inflation down to 10.6 percent in 1984 with a tight national budget, but his measures and a number of downward realignments of the lira are insufficient to compensate fully for higher inflation in Italy than in its major trading partners.
After heavy currency speculation, the government devalues the lira and suspends its membership in the ERM. The lira falls sharply and remains undervalued through 1995. The Maastricht Treaty sets out conditions for membership in the European Monetary Union (EMU), and the government introduces a series of austerity budgets to control and reduce the deficit and public debt.
Greater political stability helps the lira appreciate, reenter the ERM, and remain stable. The government works hard to meet the criteria for EMU membership. The 1997 budget deficit achieves the Maastricht Treaty target, and inflation falls to 1.7 percent. But reliance on falling interest rates to reduce public debt payments casts doubts on Italy's suitability as a member of the EMU.
In 1999 the EMU members adopt a single currency, the euro, for foreign exchange and electronic payments. January 2002 sees the euro in public circulation and the retirement of the lira. The European Central Bank now handles monetary policy. As in other European countries, there are accusations that the switch has given shopkeepers cover for price hikes.
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